New Accounting Rules Leave AOL Seeing Red

Media: Changes prompt an expected $50-billion loss, two years after a once-heralded merger.

Sometime this afternoon AOL Time Warner Inc. probably will earn the dubious honor of spilling more red ink than any company in U.S. corporate history.

With a quarterly loss expected to exceed $50 billion, in one fell swoop the world's biggest media company will lose more than the annual gross domestic product of Ecuador, Croatia, Uruguay, Kenya or Bulgaria.

The loss--which is largely on paper and reflects new accounting rules--essentially acknowledges that the merger between Internet giant America Online Inc. and media conglomerate Time Warner Inc. has fallen dramatically short of expectations.

Two years ago when the deal was announced, the two companies had a combined stock market value of $290 billion. Today, AOL Time Warner's stock is worth about $85 billion.

"It's an appalling number, bigger than the [gross domestic product] of some countries," said entertainment analyst Harold Vogel of Vogel Capital Management in New York. "Most analysts will dismiss it and say it's now behind them and doesn't matter because it's noncash. But it's an admission of a humongous mistake."

For the most part, Wall Street already has factored in the loss. AOL Time Warner's shares have fallen 41% this year, partly because the company telegraphed the eye-popping losses a few weeks ago and because of the slowdown in advertising that is hurting its properties. An AOL Time Warner spokesman declined to comment.

The accounting losses are a morning-after hangover of the wild run-up in the stock market in the late 1990s. Many companies, including America Online, used their inflated stock to buy other companies. Now, new accounting rules set by the Financial Accounting Standards Board are forcing companies to more accurately state the fair market value of those acquired assets. Often, the result is huge write-offs.

AOL Time Warner has said it expects its asset write-down to be $54 billion.

The new rules have been especially tough on industries such as entertainment, technology and telecommunications. Their stocks were hyped in the '90s, when promise often meant more than profit.

As a result, last year fiber-optics company JDS Uniphase Corp. posted a $50.6-billion annual loss because of write-downs in its assets. Telecommunications equipment maker Nortel Networks Ltd. adjusted its books to the tune of $19 billion. Vivendi Universal, which owns Universal Studios, in 2001 posted the largest loss ever for a French company at $11.8 billion, reflecting its recent acquisition spree.

"It's difficult for the typical investor to sort these numbers out. These companies are very complicated, so huge, and the accounting and reporting of the numbers is so complex," said Brian Mulligan, who had to compile similar figures when he was chief financial officer for Seagram Co. before it was acquired by Vivendi.

For more than a decade, entertainment companies often have pushed the creative boundaries in how to portray their financial results, in much the same way they creatively sell movies and TV shows.

After the 1990 merger of Time Inc. and Warner Communications to form Time Warner, investors were steered away from traditional forms of financial performance measures such as net income and earnings per share. Instead, an array of often convoluted financial yardsticks including "EBITDA," "cash flow," "free cash flow" and "pro forma" numbers were touted by entertainment companies.

"It's become like a sleight-of-hand routine at a carnival," analyst Vogel said. " 'Don't watch this hand--watch my other hand.' "

Companies such as Time Warner and Rupert Murdoch's News Corp. rarely posted a sizable annual profit but nonetheless often were lauded by Wall Street if other measures exceeded expectations. In the February news release announcing its 2001 financial results, Viacom Inc., owner of CBS, Paramount Pictures and MTV, waited until the third page to reveal it lost $224 million.

At a time when corporate earnings are coming under more scrutiny in the wake of the bankruptcy filings of Enron Corp. and Global Crossing Ltd., some critics say companies are too often downplaying profit as a measurement so they can look better to investors.

Entertainment companies, often with Wall Street's blessing, have embraced the financial measure EBITDA. It is a "profit" number that excludes many kinds of expenses, including debt interest, taxes, depreciation and amortization.

The theory was that traditional financial measurements don't accurately portray the health of companies that have invested in big projects such as cable systems, broadcast networks, technology and telecommunications networks.

Mario Gabelli, one of the nation's biggest media investors, said the numbers are merely the tools needed to evaluate a company's health, adding that an investor can't simply rely on any single one.

"It's like valuing a big diamond ring. You have to look at color, clarity and carats," Gabelli said.

One problem is that different companies use different criteria, much as if speaking different dialects of the same language.

Walt Disney Co., for example, is one of the few entertainment companies that still regularly highlight corporate earnings per share of stock. In recent years, though, it also has highlighted free cash flow because of its continuing theme park construction programs.

"We try to report our numbers in a way that is most meaningful and most clear, and I can only assume other companies present what they think is meaningful," Disney Chief Financial Officer Thomas Staggs said. "But it ends up being a hodgepodge."